Best Businesses to Start

Time Value of Money Businesses

When starting a business, making smart choices on your business model is critical. In considering the best businesses to start, you may want to look for business concepts that profit from the time value of money.

One popular way to make money is to take advantage of the time value of money.
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The time value of money is something that most people understand on a general basis but the mathematics of calculating the present value of future cash flows is not something that most people know how to do.

In other words, most people understand that it's better to get $100 today than it is to get $100 a year from now because you can make some money on the interest if you get the money now.

But if you have, say, a stream of $100 payments coming to you at the beginning of every month for the next 24 months and I offer to pay you a certain amount of money for that stream, you would be hard-pressed to define the right price to sell at (unless you are a quant jock that has studied finance).

That's because the exercise of doing that calculation involves an understanding of net present value calculations, which is the way that finance folks value a future stream of money.

Making Money From Net Present Value Calculations

There's a business opportunity in knowing how to value cash flow streams when others do not.

For example, Oasis Settlement Cash is a firm that helps people who have previously been involved in lawsuits. They are based in Northbrook, Illinois near us and are part of Oasis Legal, a large legal funding firm.

If a person has been granted a settlement in a legal case, they typically will receive a series of payments over time.

However, in many cases, those individuals need access to the cash immediately. This could be to make a downpayment on a house, to pay for a college education, or to buy a business.

Oasis Settlement Cash will do some math on the time value of money for that settlement stream. They figure out what the fair value is for the stream using what is known as a net present value calculation. Then, they offer a lump-sum payment that is less than that calculation. The difference in the two numbers is their profit.

Note that if Oasis Settlement Cash were to offer the same value as their net value calculation, they would make zero profit. It would be a similar case to a scenario in which a homebuilder were to sell the houses he built exactly at cost. I mention this because occasionally people get bent out of shape that time value of money businesses charge high fees. It's absurd because in our capitalistic system, competition will erode high profits. The more competition, the better the prices.

It's also the case that firms that buy and sell cash flows do so at considerable risk. Every calculation of a net present value is based on assumption about future interest rates. If you guess wrong on those future interest rates, you can lose money instead of making money.

Making Money on the Float

Another way to make money based on the time value of money is to leverage the float.

The definition of float has evolved over time. It tends to refer to a situation where money exists in two places at once. For example, in the old days you could write a check and deposit it into an account. While the check cleared, which could take a few days, you effectively had the money in two places and there were times when individuals received interest on both accounts. This was called "playing the float."

These days, we refer to the float as being any opportunity to make money on large amounts of funds that are in transit.

Let's look at a firm like Paypal for example. Billions of dollars flow through Paypal every day as folks use the service to send money to each other. For the sake of simplicity, let's say that Paypal takes 24 hours to process each money-sending request. In other words, they take the money out of the sender's account and then they send it to the recipient's account 24 hours later.

Few people will complain about that 24 hour delay. But think about Paypal's bank account. Billions of dollars will sit in that account temporarily. Within 24 hours, any given dollar moves on to a recipient but by that time a new dollar has come in as part of a new transaction.

The net result is that the balance of the Paypal bank account on any given day is massive, and it stays massive throughout the year. The bank pays interest on that big balance, and Paypal earns a phenomenal revenue stream, just for being in the middle of cash flows between other parties.

You get the idea. If you can start a business where you temporarily take control of large amounts of cash and do so in a continuous fashion so that you always have a high bank balance, you can make money on the float.

Next Steps for Starting Your Business

Now that you understand the way to make money based on the time value of money, use this concept as a lens when evaluating business ideas. If you can start a business that uses this technique, you may find that it's very profitable.

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What other business models are you aware of that make money from the time value of money? What do you see as the advantages or disadvantages of this type of business. We welcome all comments, questions, tips and suggestions.

Jane Wilson

8/2/2010

Time value of money is a concept I always try to keep in mind. The important thing is to find the right opportunity.